He also believes that a bond fund should be a bond fund and should not be mixed with equities because investors may already have exposure to equities or simply don’t want that exposure.
For many investors moving out of cash to purely equity based investments provides too much perceived risk.
There are two ways that investors can reduce the perceived risk, firstly to take one step up on the risk ladder to bonds, or secondly to blend bonds with equities.
Bonds are an attractive asset class for several reasons, firstly they are seen as low risk, and secondly they have delivered strong returns over the past ten years.
The difficulty is that much of the assessment is based on the past and it is very difficult to predict the future. This is important for several reasons.
Firstly we assume that because bonds have been less volatile and therefore less risky this will continue, and secondly we assume that because in the past performance has been strong it will continue. However, what is becoming increasingly clear is that the bull market for bonds is coming to an end. This means that returns will be lower and potentially volatility will increase.
We are already starting to see this where one of the weakest sectors last year was gilts and this year it has reversed that trend against all expectations. An additional factor is that different asset classes will perform differently within the bond market, so for example does an investor select investment grade, high yield, gilts etc.
Investors are becoming more aware of these challenges, as are investment houses that are bringing to market a raft of different investment solutions. This makes it incredibly hard for investors to choose the direction they should go.
One option for investors still wanting bond exposure but unsure where to go is a strategic bond fund – effectively this is a managed bond fund where the manager selects where to invest to gain the best returns. The most well-known fund in this area is the M&G Optimal Income Fund.
This fund can invest up to 20% in equities with the balance in bonds. Last year the holding in equities was around 12%, this has reduced down to below 5% this year. Some investors may be uncomfortable with the equity exposure because effectively they want a pure bond fund.
We recently met the manager of the SLI Strategic Bond Fund. We will touch briefly on the key differences and at the end we will compare performance. The SLI Fund was launched in 2009 and has returned 63.81% since launch, in comparison the M&G Fund has returned 94.80%.
On a pure basis the M&G Optimal Income Fund seems a better option. However, over three years the performance of the two funds is almost identical with the volatility on the SLI Fund being 4.22% compared to 5.19% on the M&G Fund.
So effectively the M&G Fund appears to have captured a lot more when the markets corrected in 2009 but during the more volatile period it actually hasn’t added significant outperformance.
Additionally there remains a debate on whether the size of the M&G Fund will cause problems going forward. M&G and the fund manager argue that it will not cause problems but if there is a liquidity squeeze with bonds then there is the potential that this could dampen performance.
In summary the M&G and SLI Funds are different, however for investors looking for a pure actively managed bond fund with low volatility then the SLI Fund may be the right option. For those prepared to accept slightly more volatility and exposure to equities then the M&G Fund may appeal. Although performance appears stronger with M&G it is worth considering the more recent performance.